Thursday, 17 April 2014

Greece – On the mend but still broken

The Greek government is selling bonds again but its debts require a further fix

Greece was always broken but it was not obvious until the Eurozone crisis.  With its increasingly shabby façade finally stripped away, Greece's dilapidated economy was shunned by investors and needed to be bailed out - twice.  But, with help from others, Greece is on the mend and recent progress has been rewarded by the Greek government regaining the ability to borrow from financial markets.  While this is a key step in putting the pieces back together again, a big chunk is still missing.

Shoddy foundations

The Greek economy had never been on the firmest footing.  A raft of regulations sapped the dynamism of the economy, making Greece an alluring holiday location but an unattractive place to do business.  To avoid cumbersome rules, companies typically remained small and often hide out in the shadow economy.  This resulted in Greece being mired in low productivity and chronic tax avoidance.

Investors were willing to overlook all of this once Greece joined the euro.  Despite its obvious faults, Greece was treated as if it were the same as any other country using the euro.  This gave Greece access to funds at a lower interest rate, triggering a boom in investment in property among other things.  The government joined in and ramped up spending on the assumption that the good times were here to stay.

Yet, what was seen as a blessing at the time proved to be the wrecking ball that was to bring down the house.  Cheap financing dried up with the onset of the global financial crisis and the weakened economy collapsed under the weight of excessive levels of debt.  The government needed to borrow more and more as the economy sank into recession but investors were no longer forthcoming with their cash. 

With no one willing to lend to the Greek government, the IMF and others stepped in to prevent a default due to fears that other countries in Europe would be put in peril.  The result was a prolonged economic slump as Greece struggled with the aftermath of its borrowing binge as well as with austerity measures needed to shore up the government’s finances.  The situation was so bad that Your Neighbourhood Economist was one of many who thought that the Greeks would leave the Eurozone lured by the illusion of an easy way out.

Major repairs still needed

The economic stagnation in Greece has continued with six consecutive years of recession leaving GDP around 25% lower.  Forecasters are now optimistic enough to predict that the Greek economy will grow slightly in 2014 with austerity measures expected to ease as government finances improve.  Another sign of progress is that investors are again willing to lend the government money.  The Greek government sold 3 billion euros worth of bonds earlier in April offering a yield of just under 5% after yields spiked to over 30% around two years ago.

Investors are keen to snap up debt from other peripheral countries in Europe.  This reflects brighter prospects for some countries such as Ireland and Spain.  Yet, in the case of Greece, it is more a reflection of a dearth of other investment options offering similar returns and of investors being more willing to take on risks.  That Greece can sell bonds again is a sign that the Eurozone crisis is over but the Greeks are still left with the harsh reality of excessive debt.

Exacerbated by the sharp drop in the size of the economy, the debt to GDP ratio is around 175% and still edging upwards.  Considering that the Greek economy is unlikely to generate enough of a surplus to pay off this debt, another bailout has always been on the cards.  The Greek people are also unlikely to be able to live with the burden that this brings.  Until the shackles of debt are removed, the Greek economy will never be properly fixed.

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